Europe

How Can Spain Borrow as Cheaply as the U.S.?

Here’s a mystery for you: Spain has 26 percent unemployment and a trade deficit and its national budget in the red. Its economy has been shrinking quarter after quarter since mid-2011. Nevertheless, as of last week, the Spanish government can borrow money as cheaply as the mighty U.S. government can. As the chart above shows, the yields on each government’s 5-year notes converged at 1.7 percent on April 4.

¿Qué pasa aquí? The bottom line is that this development is partly good for Spain and partly bad. The good part is that investors have pretty much repressed their fear that Spain is going to default on its debt. Bond investors are willing to accept a lower yield because they’re more confident of getting repaid in full. The bad part is that investors may be concluding that Spain has years of economic weakness ahead of it, possibly accompanied by very low inflation or even deflation. That’s another reason to accept low yields—no risk that the interest payments will be eroded by inflation. What’s true for Spain could also be true for other countries where yields have dropped sharply, including Portugal, Greece, and Italy.

I spoke to two Spanish economists working in the U.S. to get their binational perspective on the big drop in Spanish borrowing costs: Angel Ubide, a senior fellow at the Peterson Institute for International Economics in Washington, and Mauro Guillen, director of the Joseph Lauder Institute at the University of Pennsylvania in Philadelphia. Here’s what they said:

Angel Ubide:
“To me it’s very simple. There was a mistake being made in the last two or three years. The market jumped into the assumption that any country that would require assistance from the IMF [International Monetary Fund] and/or ESM [European Stability Mechanism] and other European countries would be at risk of a debt restructuring, a PSI [private-sector involvement, meaning bondholders would suffer]. That hypothesis was wrong.”

Greece managed to stay in the euro zone, and the European Central Bank pledged to buy bonds of countries like Spain that got into trouble. Meanwhile, Spain and others reduced their costs and improved their competitiveness, while their trading partners outside Europe thrived, Ubide says. “In the last year or year and a half, exports from Spain and Portugal have boomed.”

“One reason yields are coming down is that there is a big output gap. You need a stimulatory policy.” In other words, yields on Spanish debt are responding to the outlook for growth and inflation, as in the U.S., not to the risk of default. “The euro area is becoming like a regular country.”

Mauro Guillen:
“The crisis has been pretty severe. Spain can’t devalue [because it shares the euro]. The peseta was devalued by 25 to 30 percent in past crises. This time Spain had to do internal devaluation [i.e., cutting costs]. Spain over the last five years has more or less closed about 50 percent of the gap in terms of competitiveness.”

“We still need to know whether this is sustainable or not. The budget deficit is still running relatively high. All of these situations would have been totally impossible without what [ECB President Mario] Draghi did—the promise to purchase Italian and Spanish sovereign debt [if necessary]. Also, the banks have been able to go to ECB and get money at near zero interest rates.”

“Of course the austerity measures will eventually work, but it’s going to take them a long time to work. [...] Surplus countries such as Germany should increase their wages. The new governing coalition in Germany seems willing to allow wages to go up.”